Archive for 2019

Review of Model Portfolios

Tuesday, September 17th, 2019

What’s Inside:

  • 19 model portfolios potentially useful as references from which to design a portfolio suitable for you
  • OWN / LOAN / RESERVE and sub-class composition
  • 1-mo, 3-mo, 1-yr, 3-yr, and 5-yr total returns
  • Trailing yield, standard deviation, Sharpe Ratio and maximum drawdown, duration of drawdown, safe withdrawal rate and perpetual withdrawal rate since 1970
  • ETFs representing each of the sub-classes used in the portfolios

These portfolios may be useful to you a starting reference points to design a portfolio best suited to you and your life stage, goals, means, limitations preferences, risk tolerance and other factors.

There are many model investment portfolios, perhaps too many, model portfolios to be found.  The could be bewildering.  This is an attempt to present a limited number of portfolios that cover the broad spectrum of investor needs and circumstances.

Before we look at them, remember that asset allocation is a far more important determination of your investment returns and portfolio volatility and periods of maximum drawdown than the specific securities you chose to represent asset categories in your portfolio.

FIVE STEP PORTFOLIO DESIGN PROCESS

The five steps might be best divided between long-term ideas and intermediate-term to short-term ideas (Investment Policy and Investment Strategy).

Investment Policy:

  • Decide the mixture of the three “Super Classes” OWN, LOAN and RESERVE to use in the portfolio
  • Decide which asset Sub-Classes to include and which to exclude within each super-class for the portfolio (e.g domestic or international stocks or gold or commodities or real estate in the OWN super class)
  • Decide upon the normal, or long-term, weights for each of the Super Classes, and to the Sub-Classes in the portfolio

Investment Strategy

  • Deviate from the long-term policy weights of asset classes up or down (overweight or underweight) in attempt to capture excess return, or to manage portfolio volatility, or maximum drawdown risk
  • select individual securities or funds within an asset class to achieve superior returns relative to that asset class (expense levels are a major contributor to differences in returns for funds)

It is best to commit the Investment Policy to writing, along with other important factors such as goals, means and risk tolerance and other limitations, to serve as a reference and possible behavioral control when markets, news and situations rise your positive or negative anxiety. 

Before doing anything rash or spontaneously, take a deep breath, pull out and read your written Investment Policy, then ask yourself whether what you are about to do is appropriate.  Maybe referring back to that document prepared when your emotions were calm and news flow was normal will modify the action you are about to take.

The portfolio models below deal only with the three steps of Investment Policy.

Note that investment models for pension plans and endowments are of necessity generally different from those suitable for most individuals.  Pensions and endowments are generally presumed to be perpetual, or at least to last longer than a typical human life.

Individuals generally have finite time frames for their portfolios (let’s ignore the ultra-wealthy whose portfolios that may be perpetual).  Individuals go through three broad phases:

  • accumulation with aggressive risk investing with gains priority (early stage years)
  • continued accumulation with moderate risk investing, seeking gains, with some income focus (middle stage years)
  • withdrawal with conservative investing, with income priority at least equal to gains priority and limiting volatility and maximum drawdown risk (late stage years). 

As a result, “glide path” considerations come into play for individuals.  There is certainly variation among institutions and advisors about an appropriate glide path, but the glide path published by Vanguard is somewhat in the middle of the pack. That makes it a useful data point to consider (not to be bound to it, but to consider it when designing a portfolio).

This is their glide path.  I have added the concept of the ratio of Human Capital to Financial Capital to the customary age or years to retirement dimensions as a glide path issue.

Human Capital (“HC”) is the present value of future savings to be added to the portfolio from money earned by work.  Financial Capital (“FC”) is the market value of the portfolio.  The Human Capital-to-Financial Capital Ratio is HC/FC and is an important consideration along the portfolio allocation glide path.

(Click images to enlarge)

19 Model Portfolios:

The tables that follow pursue different levels of risk, or life stage utility as contemplated by their authors:

Growth:

  • IVY portfolio
  • Pinwheel portfolio
  • Swensen portfolio

Moderate:

  • 3 Fund portfolio
  • Bernstein portfolio
  • Golden Butterfly portfolio

Conservative:

  • Permanent Portfolio
  • Dalio portfolio
  • Swedroe portfolio

Classic:

  • Bogle 60/40 portfolio

Vanguard Life Stage (age / years before retirement):

  • 35 / -30
  • 45 / -20
  • 55 / -10
  • 65 / 0
  • 75 / +10

Vanguard Risk Levels:

  • Aggressive Growth
  • Moderate Growth
  • Conservative Growth
  • Income

This table shows these metrics for the portfolios:

  • OWN / LOAN / RESERVE allocation
  • # of positions in the portfolio
  • Total return: 1 mo, 3 mo, 6 mo, 1 yr, 3 yrs and 5 yrs
  • Trialing 12-month trailing yield
  • 3-year standard deviation
  • 3-year Sharpe Ratio (basically return over risk)
  • Maximum drawdown in last 6 years

This table for the same 19 models, repeats the very important OWN, LOAN, RESERVE Super Class allocation, then shows key sub-class allocations between US stocks, International Stocks, US Bonds, International Bonds, Cash and Other.

In this chart we have selected an ETF to represent each of the sub-classes that each model specifies, showing the percentage allocation per sub-class.

In this last table, for all but the Vanguard models, you see these performance dimensions of each portfolio since 1970, as rendered by portfoliocharts.com.

The two most obvious findings are that the Classic John Bogle 60/40 portfolio consisting of 60% S&P 500 and 40% US Aggregate Bonds has the least attractive history; and the Golden Butterfly has the most attractive set of long-term metrics.

Pinwheel has the highest average return and the most attractive overall metrics set in the Growth group. 

Golden Butterfly has the highest average return and the most attractive metrics set in the Moderate group. 

Permanent may have the most attractive set in the Conservative group, but does not have the highest average return (4.8% versus 5.3% for the other two).  Dalio has a 5.3% average return, a better maximum drawdown than Swedroe, but a 10-year duration of the maximum drawdown versus only 5 years for Permanent.

The long-term metrics for the models are (in order):

  • Average Return Since 1970
  • Baseline 15-Year Return*
  • Baseline 15-Yr / Av Since 1970
  • Baseline 3-Year Return*
  • Standard Deviation
  • Ulcer Index
  • Deepest Calendar Drawdown
  • Longest Drawdown (yrs)
  • Safe 30-Yr Withdrawal Rate
  • Perpetual Withdrawal Rate

* Baseline excludes the worst 15% of annual periods.

“Ulcer Index” measures short-term downside risk (depth and duration of price declines), over 14 days in this case.

Note: Golden Butterfly is data mined since 1972, whereas the others were developed using data from periods ending various multiple years ago and/or are based on investment logic.

Note: Swensen revised his model a few years ago to increase emerging markets to 10% and reduce real estate to 15%.

These are the ETFs used as proxies for the sub-classes in the portfolios to generate the short-term metrics, sub-class and sector composition via Morningstar.  PortfolioCharts.com used other data to generate the long-term metrics from 1970.

Total US Stocks VTI
Large-Cap Value SPY
Mid-Cap Blend MDY
Small-Cap Blend IWM
US Small-Cap Value VBR
Developed ex US VEA
International VXUS
International Small-Cap Value DLS
Emerging Markets VWO
Emerging Markets Value DEM
Equity REITs VNQ
Gold GLD
Commodities DBC
Aggregate US Bonds BND
Aggregate Int’l Bonds BNDX
ST Inflation Protected Treas. VTIP
Long-Term Treasuries TLT
Intermediate-Term Treas. IEF
Short-Term Treasuries SHY
Cash BIL

There are many more portfolio models, but these are a good departure point for thinking about what may be best for you.

Cautionary Country and Region Economic Conditions

Sunday, September 15th, 2019

What’s Inside:

  • Purchasing Managers’ index for selected countries and regions
  • Long-term PMI trend lines
  • World Bank GDP growth forecasts by country and region
  • Valuation metrics for ETF proxies for selected countries and regions
  • 3-Year monthly return chars with trend lines for proxy ETFs

Purchasing Managers’ Index

The PMI (Purchasing Managers’ Indexes) around the world forecast weak growth to negative growth in manufacturing, and weak to moderate growth in services over the near term; with the composite of manufacturing and services forecasting weak growth. 

PMI is based on a monthly survey of businesses to gauge current conditions and trend.  It is a short-term coincident indicator with short-term forecasting utility.  Once plotted in a long-term chart, the PMI may have intermediate-term trend forecasting utility.

The index centers around 50 and ranges from 0 to 100.  Values above 50 indicate growth and values below 50 indicate contraction.

In the table above, pink shaded cells show contraction; and bold red values indicate the current index value is lower than the prior monthly value.

United States manufacturing is hovering just above the growth flat line, as does services.

The Eurozone is in clear manufacturing contraction, but with moderate services growth.

China manufacturing is barely growing after slightly contracting.  Its services are in mild growth.

Japan manufacturing is in contraction, and services are growing modestly.

Germany is in strong manufacturing contraction, and services are growing moderately.

United Kingdom is in manufacturing contraction, and services are barely growing.

World and United States PMI Trend Lines

This world composite PMI trend line shows the world slowing.

This USA manufacturing PMI trend line shows the USA slowing and at the lowest rate of manufacturing growth since 2013

This USA services PMI shows the USA slowing.

These trend line charts are from Trading Economics.

World Bank GDP Growth Forecasts

The World Bank sees GDP growth slowing (not declining but growing more slowly) in 2020 compared to 2019 in the United States, Euro Area, Japan and China.

It sees GDP growth increasing in Brazil, Mexico and India.

China and India have the highest expected 2020 growth rate among the listed countries at 6.0% and 7.5% respectively.  That compares to expected GDP growth in the United States of 1.6%; Euro Area 1.3% and Japan 0.6%.

This chart looks at the year-over-year GDP growth rate of the selected countries and regions.

This chart compares the GDP growth rate of the selected countries and regions each year.  China and India have been the clear growth leaders.

Comparative Metrics of Proxy ETFs for the Countries and Regions

It is important to preface this information with a note that the GDP growth rate of each country or region has different correlations to the performance of the stocks listed there.

For example, a country whose broad stock market has a high percentage of globally diversified listed stocks (e.g Switzerland or the Netherlands) may correlate more with the World GDP growth rate than the local country GDP growth rate; while a country whose broad index has mostly local operators (e.g. Vietnam) may correlate more with the local GDP growth rate.

The economy and the stock market are two different things at any given moment, but ultimately they tend to relate to each other over the long-run.

The Euro Area and Mexico have the highest current dividend yield among the selected countries and regions; while Brazil and Mexico have the highest cash flow yield (cash flow divided by price).  However, when normalized relative to the debt level of US stocks, Japan, China and Mexico have the highest cash flow yields.

Mexico and the United States have the highest expected earnings growth rate over the next 12 months. 

Looking backwards three years, the United States and Japan have the lowest level of price volatility.

Proxy ETF Trends

These charts show the monthly total return and the 10-month moving average (equivalent to the 200-day average) of proxy ETFs for the selected countries and regions.

The USA is in a long-term up trend.  Brazil has been in an up trend for about a year.  World stocks and Euro Area stocks are beginning to form an intermediate up trend line.  

Japan has made a serious break above its trend line, which has itself has not yet turned up.

India’s trend line is slightly positive, but the price is below the trend line.

China has just begun to turn up the tip of the trend line.

Mexico’s trend line is still pointing down, but the price is slightly above “trying” to reverse the trend direction. 

Symbols Explored in this Note:

VT, VTI, EZU, EWJ, MCHI, EWZ, EWW, INDA

 

 

USD Reserve Currency Status Eroding Slowly But Surely

Monday, July 1st, 2019

Wall Street Journal reported a few days ago:

Secretary General of the European External Action Service (EEAS), Helga Schmid, held a meeting to announce that Europe has found a way of circumventing U.S. sanctions on Iran. The meeting was attended by representatives of China, France, Germany, Russia, the United Kingdom, and Iran.

The governments of France, Germany and the United Kingdom have developed a special purpose vehicle called INSTEX to enable European businesses to maintain non-dollar trade with Iran without breaking U.S. sanctions.

INSTEX bypasses SWIFT, which includes US banks and US Dollars, was operating and processing transactions on Jun 28.

Bypassing SWIFT is intended to allow those trading with IRAN to avoid US ability to veto transactions because INSTEX does not involve US banks or US Dollars.

INSTEX is open to all EU member states and there is a mechanism in place or contemplated that would allow non-EU states to join (read that China, Russia and others).

China has already been arranging to purchase oil in exchange for their own currency instead of US Dollars.

These two measures are inflection points that  indicate the potential eventual end to the near total dominance of the US Dollar as the world’s reserve currency. More such arrangements may come into play if we over-use our banking system and our currency as a bludgeon to implement and enforce our foreign policy, when our allies are not on our side.

If the US Dollar loses that reserve currency status, we may find that our ability to fund our continual and even increasing national deficit becomes limited in the amount of Treasury debt we can sell, or the price we must pay to borrow the money. Either way, a major change in our way of life and in our markets would surely follow — most likely quite unpleasant.

Of this, ZeroHedge said, “…once those who benefit the most from the status quo openly revolt against it, the countdown to the end of the USD reserve status officially begins.”

This is what Allianz Global Investors said a year ago:

The US dollar has long been the currency of choice for banking and trade, and for valuing all other currencies. This has brought the US enormous economic benefits and significant structural downsides. Yet a shift away from the dollar may have begun, which could help the global economy in the long run.

Key takeaways

  • In years past, the denarii, ducat, guilder and pound each took a turn as the world’s reserve currency. Today, it’s the US dollar. Will the euro, renminbi or yen be next?
  • Central banks hold fewer US dollars than they did in 2004, and fewer international payments are being settled in dollars
  • If the dollar were to eventually lose its reserve status, its exchange rate could fall, US interest rates could suffer, and US equities and fixed income could potentially underperform

Mark Carney Bank of England Governor said this six months ago:

“I think it is likely that we will ultimately have reserve currencies other than the U.S. dollar. … the evolution of the global financial system is currently lagging behind that of the global economy … for example, emerging-market economies’ share of global activity is now 60%, but their share of global financial assets lags behind at around one-third.” He added that half of international trade was meanwhile invoiced in U.S. dollars, even though the U.S. share of international trade was only some 10%. He said further,“As the world re-orders, the disconnect between the real and financial is likely to reduce, and in the process other reserve currencies may emerge.”

Carney does not predict a rapid change, but an inevitable one.

What makes a currency a reserve currency?

Wolf Street pointed out 3 months ago:

“The degree of dominance of the US dollar as global reserve currency is determined by the amounts of US-dollar-denominated financial assets – US Treasury securities, corporate bonds, etc. – that central banks other than the Fed are holding in their foreign exchange reserves. The dollar’s role as a global reserve currency diminishes when central banks shed their dollar holdings and take on assets denominated in other currencies.”

In Q4 2018, central bank holdings of other countries currencies was as follows:

  • Dollar: 61.7%
  • Euro: 20.7%
  • Japanese yen: 5.2%
  • UK pound sterling: 4.4%
  • Chinese renminbi: 1.9% (record)
  • Canadian Dollar: 1.8%
  • Australian dollar: 1.6%
  • Swiss franc: 0.15%
  • Other: 2.48%

The Euro was zero a couple of decades ago, and the USD was a little over 70% at that time.

The USD share has been a lot worse at 46% in 1991, and we are still the reserve currency, but as China trades it own currency for oil with Iran, and the EU INSTEX facility trades non-Dollar with Iran, key adverse trend development is evident.

If nations increase trading in non-Dollar ways, the percentage of other (non-Fed) holdings of US Dollars will decline, and with it our reserve currency status.

QUARTZ reported on the history of reserve currencies 18 months ago:

A team led by Barry Eichengreen said, “From this vantage point, it is the second half of the 20th century that is the anomaly, when an absence of alternatives allowed the dollar to come closer to monopolizing this international currency role,” 

For at least 70 years, the US dollar has been the world’s dominant currency. …This dominance is historically unusual … Eichengreen and his co-authors find that reserve currencies can and do coexist. … In the future, the dollar will be forced to share prominence with the yuan and the euro, in particular. …

…If the policies of the governments and central banks responsible for these currencies remain sound and stable, this can be a smooth evolution. On the other hand, if there is some kind of policy shock… it’s possible to imagine things suddenly changing. …

…There are four things you need in order for your currency to play a global role: size, stability, liquidity, and security. …

…The optimistic path is where globalization continues at a more measured pace than in the recent past, supported by a global financial system that rests on three pillars—the dollar, the euro, and the renminbi.

The pessimistic scenario is that that progress is too slow and something happens to derail confidence in the dollar. Meanwhile, the euro and the renminbi have not had time to step up and a global liquidity crisis develops that takes globalization down with it. We are more inclined towards the first scenario, but we think it’s worth worrying about the second.

The Balance profiled the current Dollar dominance 3 months ago:

The relative strength of the U.S. economy supports the value of its currency. It’s the reason the dollar is the most powerful currency. Around $580 billion in U.S. bills are used outside the country. That’s 65 percent of all dollars. That includes 75 percent of $100 bills, 55 percent of $50 bills, and 60 percent of $20 bills. Most of these bills are in the former Soviet Union countries and in Latin America. They are often used as hard currency in day-to-day transactions.

Cash is just one indication of the role of the dollar as a world currency. More than one-third of the world’s gross domestic product comes from countries that peg their currencies to the dollar. That includes seven countries that have adopted the U.S. dollar as their own. Another 89 countries keep their currency in a tight trading range relative to the dollar.

In the foreign exchange market, the dollar rules. Ninety percent of forex trading involves the U.S. dollar  … Almost 40 percent of the world’s debt is issued in dollars. As a result, foreign banks need a lot of dollars to conduct business.

In 2009, a big panic year, China and Russia called on the IMF for a new global currency based on a basket of national currencies. China was concerned that the trillions it holds in dollars would be worthless if Dollar inflation set in as a result of increased U.S. deficit spending and printing of U.S. Treasurys to support U.S. debt.

[QVM note] It’s been ten years and it hasn’t happened, but the idea is still out there.   On the other hand our liberal use of  Dollar trading sanctions against our allies over Iran, is weakening our alliances and strengthening efforts to supplant the Dollar.]

Dollar (UUP), Euro (FXE), Yen (FXY) and Yuan (CYB) are key currencies in this discussion.

 

 

Multi-Country Interest Rates and Credit Ratings

Sunday, March 24th, 2019

These rates and ratings are as of Friday March 22, 2019 and were sourced at www.WorldGovernmentBonds.com.

The tables present country, S&P credit rating, 10-year bond yield and central bank rate.

The tables are ordinated first by credit rating, then by central bank rate.

QVM Market Notes: S&P 500 Technical Charts

Friday, March 8th, 2019

Let’s explore several ways to view the last 1+ year of S&P 500 price behavior through charts.

There are no absolute laws in finance as there are in physics, chemistry and mathematics; just long-term tendencies arising from seemingly random short-term price moves, punctuated by infrequent large price declines followed by gradual recovery.   However, some chart patterns are useful to suggest which tendency is more likely than not to follow particular recognizable price patterns. 

Realize that the movement of stock prices does not reflect the view of all holders, but rather of the active traders most of the time and the last traders to act.  In the short-term price movements are not based on fundamentals of valuation, but rather on news flow and sentiment.  There are vast pools of quiet holders who are doing nothing while the price moves up, down and sideways on the charts.  For most investors, most of the time being part of the quiet money by doing absolutely nothing is the best course of action.

Visual interpretation of chart patterns (“technical analysis”) at a minimum has validity in that over time technically oriented investors have come to expect prices to tend to react to certain chart patterns in a certain way.  Whether the pattern can be traced back to specific fundamental, macro-economic or sentiment causes becomes somewhat unimportant if time and time again certain patterns fairly reliably are followed by certain price behaviors.  Technical analysis becomes self-validating as traders in the aggregate come to believe that chart pattern signals move prices in a certain way with favorable probability.

For those of us who are not traders, chart analysis can still be useful by believing in the believers tendency to act, as we decide things like should I buy that fund or stock today, or wait for the chart pattern to improve.  Accordingly, for those of us who have reserve cash that we want to put to work in US stocks, the current chart patterns suggest waiting a bit for the pattern to resolve its trend direction intentions, although if you have a 5-year to 10-year perspective, the charts might be more useful as entertainment, the same way you might watch a football game, just to see who wins.

And by the way, the football analogy for support and resistance isn’t a bad one.  You could think of support and resistance price levels as analogous to the defensive line players in football, and the price as the ball carrier, trying for a first down or a breakout run for a touchdown.  When the defensive line (the support or resistance level) is effective, the ball carrier (the price) is prevented from making headway, and may actually be pushed back a bit.  When the defense is not effective, the ball carrier (the price) breaks out and moves past the line of defense (the support or resistance level) until tackled (a short price move past support or resistance) or finds and open field to run with major yardage gain.

CHART 1:

Chart 1 is a daily chart showing that we have been in a trading range from 2600 to 2800 for over a year, with a  breakout UP and a  breakout DOWN, with a return to the trading range.  There have been more “tops” (shown as red elipses) than “bottoms” (shown as green elipses) which suggests there may be more in the way of short-term ceiling (“resistance”) around 2800 than there is a short-term floor (“support”) around 2600. 

There is a tendency for prices to bounce down from resistance and bounce up from support, until the market makes up its mind about trend direction. Typically, once pierced former resistance becomes new support; and once pierced former support becomes new resistance – both of these tendencies failed in this case, as the market was unable to decide to continue the nascent breakouts.  We are in a period of wide range consolidation.  At the end of a long period of consolidation, there is a tendency for strong directional moves continuing or reversing a former trend.

CHART 2:

Chart 2 is a daily “box chart” to filter out noise in price movements.  The chart does not have a linear timeline, but rather only plots a new box when the price moves by more than the average move of the last 14 market days. It simply shows the trading range, tops, bottoms and breakouts more clearly than the noisy daily Chart 1.

Chart 3:

Chart 3 is a repeat of the daily “box chart” but used to identify a different pattern, called a “head and shoulders formation”. 

Head and shoulders refers to a top followed by a shallow dip, followed by a significantly higher top, followed by a significant decline, followed by a lower top; as indicated by the circled areas in the chart.   The line drawn under the bottoms is called the neckline.  When found this pattern tends to be a sign of a major trend top.  If the price after the right shoulder drops below the neckline, it tends to go as far below the neckline as the head is above the neckline. 

We can see that in Chart 3. The price did go below the neckline, and it did go about as far below the neckline as the head is above, then it began its strong January recovery; negating the implications of the apparent head and shoulders.

Chart 4:

Chart 4 is another repeat of the daily “box chart” with a “Russian Doll” view (a doll within a doll – a pattern within a pattern).  Could it be that the current run-up is merely plotting out the beginning of the right shoulder of a wider head and shoulders pattern?  Don’t know, but we should find out pretty soon.  If it is a larger head and shoulders, that would be a bad sign.  If the breakout continues up to about 2900, then like the Etch-a-Sketch toy of our childhoods, all the former patterns are effectively erased from a prediction perspective – then they don’t matter anymore.

Chart 5:

Chart 5 is a standard daily chart with 7 indicators plotted upon it, to see if they confirm, disagree with or portend price action.

Moving Average:  This chart shows the 200-day average (the thin dashed line in the middle of the green shaded area) to be nearly flat, slightly up, after a recent dip (not Bearish, not Bullish, just Neutral)

Standard Deviation:  The outer boundaries of the green shaded area mark a 1 standard deviation distance from the 200-day average.  About 67% of the time you would expect the price to be between those two boundaries, as it is now – normal.  The outer boundaries of the beige shaded area are 2 standard deviations.   About 96% of the time you would expect the price to be between those boundaries.  To be outside of them, there should be a strong justification, or a reversion back toward the mean (the 200-day average) would be expected.

Percentage Change: The red dashed vertical line shows that we essentially already had the Bear we have all been looking for (a mini-Bear at just down 20%, but it did happen). It was very quick, so probably did not clear out all of the weak hands. The average Bear takes about 1.5 years to reach its bottom, and then 3+ years to regain the former peak.  This one happened so fast that it probably did not flush out all of the investors who would run away in a typical deeper Bear building over a longer period.  That probably means there are remaining weak hands to be concerned about.

Advance/Decline Percentage: The first panel below the price chart is the Advance/Decline Percentage.  AD Percent = (Advances Less Declines) / Total Issues. 

It shows that when the percentage is down to about -90% (a 90% down day)  by hitting the bottom blue horizontal line, a bottom is near or at hand, and that a strong up day is likely to follow.  That happened clearly at the end of December with a 90% up day following the 90% down day.  It also gave clues to the weakening of the most recent rise as it approached the current downturn.

Percent of Constituents Above Moving Averages: The second panel below the price chart plots the percentage of the S&P 500 constituents that are above their 200-day average in blue and the percentage above their 20-day average in dashed red.

Levels below 30% (the lower blue horizontal line) suggest oversold conditions and the probability of an increase in buying.  The indicators strongly suggested a bottom in late December, and shows the recent overbought condition (plots above 70%, the upper blue horizontal line) to be fading, which is consistent with the current dip in the price.

Money Flow Index: The third panel below the price panel is the Money Flow Index.  It measures the amount of money traded in the security on positive days versus the amount of money flowing through the security on negative days over a selected period of time (in this case 14 days).  Levels below 20 are considered oversold (and due for an upward turn), and levels over 80 are considered overbought (and vulnerable to a downward turn, although overbought conditions may last longer than oversold conditions).  The direction of movement of the indicator is instructive, and crossing the 50 level might be considered transitioning between positive and negative condition.

Money Flow was oversold at the December bottom, flirted with overbought in January, and has been losing steam in February, crossing below 50 yesterday.   Overall, it suggests more downward movement for a while.  Basically this confirms the current dip.

MACD: The bottom panel is the popular MACD (Moving Average Convergence/Divergence oscillator) short-term indicator. It tracks the positions of short-term moving averages relative to each other.  When the shorter rise above the longer, that is positive, and when the shorter falls below the longer that is negative.   We show it here as a histogram.

It reached its peak in mid-January, declined steadily and went negative on February 28, and continues to become more negative – also indicating more probable downward movement in the S&P 500 in the short-term.

Chart 6:

Chart 6 is a quarterly chart of the S&P 500 since its inception in 1957 (241 quarters) along with the 1-quarter rate of change of the S&P 500 price.  The 2018 Q4 decline was 13.97%.  That level or worse noted by the dashed red horizontal line has occurred only 10 times in 241 quarters, which makes it unusual.  The vertical blue lines helps show where in the index price history those strongly negative quarters occurred.  They tended to occur at bottoms, which is an encouraging sign for intermediate-term potential for the index.

S&P 500 Resistance and Support Levels

Monday, March 4th, 2019

In the long-term price chart visual pattern recognition (“technical analysis”) doesn’t tell you much. In the short-term, it can often be a good guide when deciding when to make the next addition to a position.

Right now the S&P 500 chart suggests holding off on making additional investments in US large-cap stocks until the technical condition becomes Bullish – it is now unclear. It does not suggest reducing US equity exposure, but it does not suggest increasing US equity exposure either.

If you have a new slug of money to invest, or have a cash reserve position to invest, it may be prudent to do that when the technical indicators are more favorable.

Even if technical analysis is basically voodoo, like voodoo it works because people believe in it. If enough investors believe that certain current chart patterns precede and indicate certain near-term future price behavior, then they will act upon that belief, and the belief will be fulfilled – perception is reality.

“Support” and “Resistance” are among the more solid technical indicators. Double and Triple Tops are a commonly accepted indication of a price resistance level. Double and Triple Bottoms are a commonly accepted indication of a price support level.

Prices tend to bounce down from resistance and bounce up from support. When prices move above resistance or below support, they tend to move by a significant amount. That makes support and resistance useful for various kinds of short-term investment decisions, among which is deciding to make that next investment now, or to wait a little while for the price to decide whether to be bounded by the support and resistance, or to break free to continue a trend.

Two other common ways support and resistance are used are in selecting stop-loss exit points, and it selecting strike prices when buying or selling options.

Right now, today, I suggest deferring that next investment into the S&P 500 (or comparable fund) until the price stops playing with the current resistance level (the red dashed line at approximately 2800, formed by the triple top in 2018 shown by red down arrows).

If resistance proves durable (resists multiple attempts by the price to go above it), a material decline in the price of the index would normally be expected, at which point the support level (the dashed green line at approximately 2650, formed by the double bottom in 2018) would then move front and center. If the price does go above the resistance level and remains there for a few days, or moves strongly above the resistance level, a significant price increase would normally be expected. If the price does go below the support level and remains there for a few days, or moves below strongly, a significant price decrease would be expected.

2800 resistance and 2650 support are important lines of demarcation between Bullish and Bearish market views of the index.

The farther apart the failures (“tops”) are and the deeper the drop after, the more meaningful they are as resistance indicators. The two runs at resistance over the last few days are encouraging, because there was not a material decline between them, and the index came right back to try again.

A nice example of support and resistance in play at the bottom of the Bear market after the DotCom crash shows the strong upward price move after the price broke above a resistance level. The tops and bottoms that formed those resistance support levels were spaced apart in months and were at price levels more than 10% apart (both very meaningful). That triple bottom around 800 after a Bear market decline was strongly encouraging, and when the price moved above the resistance around 950, the index moved more than 20% higher over the next 6 months.

Support and resistance can be useful tools to help confirm changes in the direction of a trend.